Post on 28-Dec-2015
10
1
Fixed Assets and Intangible Assets
CHAPTER E – 3, 4, 13, 18, 19, 20, 23, 26; P - 2A
PRINCIPLES OF ACCOUNTING II
10
2
1Describe, classify, and account for the cost of fixed
assets.
Learning Objective Number
10 Nature of Fixed Assets
Fixed assets are long-term or relatively permanent assets, such as equipment, machinery, buildings, and land. Other descriptive titles for fixed assets are plant and equipment.
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Fixed assets have the following characteristics:1. They exist physically and, thus, are
tangible assets.2. They are owned and used by the
company in its normal operations.3. They are not offered for sale as part of
normal operations.
Nature of Fixed Assets
10
Classifying Costs
Nature of Fixed Assets
10 Building a Restaurant
What do you need?
1.Land2.Building3.Equipment4.Fixtures5.Land
Improvements
Most importantRent, lease, buy, or
build
Location
10 Nature of Fixed Assets
Costs of Acquiring Fixed Assets
10
Costs of Acquiring Fixed Assets
Nature of Fixed Assets
10 Nature of Fixed Assets
Costs of Acquiring Fixed Assets
10 Nature of Fixed Assets
Costs of Acquiring Fixed Assets
10
Cost of Acquiring Fixed Assets Excludes:
1. Vandalism
These costs are expenses.
2. Mistakes in installation
4. Damage during unpacking and installing
3. Uninsured theft
5. Fines for not obtaining proper permits from government agencies
Nature of Fixed Assets
10
Initial cost of land ($30,000 + $270,000) ........................... $300,000 Plus: Legal fees .............................................. $ 1,425 Delinquent taxes.................................... 12,000 Demolition of building .......................... 18,500 31,925 $331,925 Less: Salvage of materials ......................................... 4,500 Cost of land ................................................................. $327,425
Exercise 10-3
10
• Expenditures that benefit only the current period are called revenue expenditures.
Capital and Revenue Expenditures
• Expenditures that improve the asset or extend its useful life are capital expenditures.
10
Normal and ordinary repairs and maintenance
REVENUE EXPENDITURES
CAPITAL EXPENDITURES
Additions, improvements, and extraordinary repairs
Capital and Revenue Expenditures
10 Ordinary Maintenance and
Repairs
On April 9, the firm paid $300 for a tune-up of a delivery truck.
This is a revenue expenditure.
10 Asset Improvements
On May 4, a $5,500 hydraulic lift was installed on the delivery truck to allow for easier and quicker loading of heavy cargo.
This is a capital expenditure.
10 Extraordinary Repairs
The engine of a forklift that is near the end of its useful life is overhauled at a cost of $4,500, which extends its useful life eight years. Work on the forklift was completed on October 14.
This is a capital expenditure.
10 Capital and Revenue
ExpendituresUsed in normal operations
10
Expenditure Capital Revenue1 X2 X3 X4 X5 X6 X7 X8 X9 X
10 X
Exercise 10-4
10
Internal Revenue Service STORY
The following is a true story, the names have been changed
to protect the innocent
The Real World
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Jones and Sons Blacktopping
15 Cherry Street Wilkes- Barre, PA 18701 Phone 570-555-0190 Fax 570-555-0191
INVOICE
INVOICE #1897 DATE: JUNE 15, 2006
TO: Fred
FOR: Mountaintop Property
DESCRIPTION AMOUNT
Paving work in Mountaintop, PA $ 3,000.00
The Real World
10 Leasing Fixed Assets
A capital lease is accounted for as if the lessee has, in fact, purchased the asset. The asset is then amortized over the life of the capital lease.
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A lease that is not classified as a capital lease for accounting purposes is classified as an operating lease (an operating lease is treated as an expense).
Leasing Fixed Assets
10
24
2Compute
depreciation, using the following methods:
straight-line method, units-of-
production method, and
double-declining balance method.
Learning Objective Number
10
Over time, fixed assets such as equipment, buildings, and land improvements lose their ability to provide services. The periodic recording of the cost of fixed assets to expense is called depreciation.
Depreciation
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1. Physical depreciation factors include wear and tear during use or from exposure to the weather.
2. Functional depreciation factors include obsolescence and changes in customer needs that cause the asset to no longer provide services for which it was intended.
Depreciation
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Factors in Computing
Depreciation1. The asset’s initial cost.
2. The asset’s expected useful life.
3. The asset’s estimated residual value.
Depreciation
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The expected useful life of a fixed asset is estimated at the time the asset is placed into service. The residual value of a fixed asset at the end of its useful life is estimated at the time the asset is placed into service.
Residual Value
Depreciation
10
Depreciation Expense Factors
Depreciation
10
Use of Depreciation Methods
Depreciation
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The straight-line method provides for the same amount of depreciation expense for each year of the asset’s useful life.
Annual depreciation
Cost – Estimated residual valueEstimated life
=
Straight-Line Method
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A depreciable asset cost $24,000. Its estimated residual value is $2,000 and its estimated useful life is five years.
Annual depreciation
Cost – Estimated residual valueEstimated life
=
Annual depreciation
$24,000 – $2,000 5 years expected useful life
=
Annual depreciation
= $4,400
Straight-Line Method
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If the preceding equipment was purchased and placed into service on October 1, the depreciation would be $1,100, computed as follows:
$4,400 × 3/12 = $1,100
Straight-Line Method
Jan
Feb
Mar
Apr
May
Jun Jul Aug
Sep
Oct Nov DecJan
Feb
Mar
Apr
May
Jun Jul Aug
Sep
Oct Nov Dec
366
367
367
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The units-of-production method provides for the same amount of depreciation expense for each unit produced or each unit of capacity used by the asset.
Depreciation
per unitCost – Residual Value
Total Units of Production=
Units-of-Production Method
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A depreciable asset cost $24,000. Its estimated residual value is $2,000 and it is expected to have an estimated life of 10,000 operating hours.
Depreciation
per unitCost – Residual Value
Total units of production=
Depreciation
per unit$24,000 – $2,000
10,000 hours expected useful life
=
Depreciation per unit = $2.20 per hour
Units-of-Production Method
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A depreciable asset cost $24,000. Its estimated residual value is $2,000 and it is expected to have an estimated life of 10,000 operating hours. During the year the asset was operated 2,100 hours.
DepreciationDepreciation per Unit × Total
Units of Production Used=
Depreciation ($2.20 per hour) × (2,100 hours)
=
Depreciation
$4,620=
Units-of-Production Method
10
The double-declining-balance method provides for a declining periodic expense over the estimated useful life of the asset.
Double-Declining-Balance Method
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A double-declining balance rate is determined by doubling the straight-line rate.
A shortcut to determining the straight-line rate is to divide one by the number of years (1/5 = .20).
Hence, using the double-declining- balance method, a five-year life results in a 40 percent rate (.20 × 2).
(continued)
Double-Declining-Balance Method
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For the first year, the cost of the asset is multiplied by 40 percent. After the first year, the declining book value of the asset is multiplied 40 percent.
Continuing with the example where the fixed asset cost $24,000 and has an expected residual value of $2,000, a table can be built.
Double-Declining-Balance Method
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$24,000 × .40
1 $24,000 40% $9,600
Double-Declining-Balance Method
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
Fixed asset cost $24,000 and has an expected residual value of $2,000.
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1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760
$14,400 × .40
Double-Declining-Balance Method
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
Fixed asset cost $24,000 and has an expected residual value of $2,000.
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1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
Double-Declining-Balance Method
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
Fixed asset cost $24,000 and has an expected residual value of $2,000.
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1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
Double-Declining-Balance Method
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
Fixed asset cost $24,000 and has an expected residual value of $2,000.
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1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
Double-Declining-Balance Method
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
Fixed asset cost $24,000 and has an expected residual value of $2,000.
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1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 40% 1,244 22,134 1,866
Depreciation stops when book value equals residual value!STOP
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
Double-Declining-Balance Method
Fixed asset cost $24,000 and has an expected residual value of $2,000.
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1 $24,000 40% $9,600 $9,600 $14,400
2 14,400 40% 5,760 15,360 8,640
3 8,640 40% 3,456 18,816 5,184
4 5,184 40% 2,074 20,890 3,110
5 3,110 – $2,000 1,110 22,000 2,000
Desired ending book
value“Forced” annual
depreciation
Double-Declining-Balance Method
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
Fixed asset cost $24,000 and has an expected residual value of $2,000.
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If the preceding equipment was purchased and placed into service on October 1, depreciation for the year ending December 31 would be $2,400, computed as follows:
$9,600 × 3/12 = $2,400
Double-Declining-Balance Method
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
1 $24,00040% $2,400 $2,400 $ 21,600
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The depreciation for the second year would then be $8,640, computed as follows:
$8,640 = [40% × ($24,000 – $2,400)]
Double-Declining-Balance Method
Book Value Accum. Beginning Annual Deprec. Book Value Year of Year Rate Deprec. Year-End Year-End
1 $24,00040% $2,400 $2,400 $ 21,600
2
1 $24,00040% $2,400 $2,400 $ 21,600
2 21,60040% 8,640 11,040 12,960
10 Summary of Depreciation
Methods
10 Comparing Depreciation
Methods
10
Straight-line method:
( $172,000 - $20,000 ) ÷ 8 = $19,000
Declining-balance method:
Year 1 $172,000 x 25% = $43,000
Year 2 ( $172,000 - $43,000 ) x 25% = $32,250
per year
Exercise 10-13
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Straight-line method:Cost of asset 380,000
Residual value 36,000
Depreciable cost 344,000
( 380,000 - 36,000 ) ÷ 4 = $86,000 per year
Problem 10-2A
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Units-of-production method:Cost of asset 380,000
Residual value 36,000
Hours 8,000
( 380,000 - 36,000 ) ÷ 8,000 = $43
2009 3,000 @ $43 = $129,000*
2010 2,500 @ $43 = $107,500*
2011 1,400 @ $43 = $60,200*
2012 1,100 @ $43 = $47,300
per hour
Problem 10-2A
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Declining-balance method:Cost of asset 380,000
Residual value 36,000
Depreciable cost 344,000
2009 ( 380,000 x $0 ) x 50% = $190,000
2010 ( 380,000 - $190,000 ) x 50% = $95,000
2011 ( 380,000 - $285,000 ) x 50% = $47,500
2012 ( 380,000 - $332,500 ) x * = $11,500
$344,000* Book value should not be reduced below the residual
value of $36,000.
Problem 10-2A
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Depreciation Expense a. Straight- b. Units-of- c. Double- Line Production Declining-Balance Year Method Method Method
2009 $ 86,000 $129,000 $190,000 2010 86,000 107,500 95,000 2011 86,000 60,200 47,500 2012 86,000 47,300 11,500* Total $344,000 $344,000 $344,000
Problem 10-2A
10 Depreciation for Federal Income
Tax
The Internal Revenue Code specifies the Modified Accelerated Cost Recovery System (MACRS) for use by businesses in computing depreciation for tax purposes.
10
MACRS specifies eight classes of useful life and depreciation rates for each of the eight classes. The two most common classes are the 5-year class (includes automobiles and light duty trucks) and the 7-year class (includes most machinery and equipment).
Depreciation for Federal Income Tax
10
For the five-year-class assets, depreciation is spread over six years, as shown below.
Depreciation for Federal Income Tax
10
A machine purchased on January 1, 2009, for $140,000 was originally estimated to have a useful life of five years and a residual value of $10,000. The asset has been depreciated for two years using the straight-line method.
Revising Depreciation Estimates
$140,000 – $10,000
5 years
Annual Depreciation
(S/L)=
$26,000 per year
Annual Depreciation
(S/L)=
(continued)
10
At the end of 2011, the asset’s book value is $88,000, determined as follows:
Asset cost $140,000Less accumulated depreciation
($26,000 per year × 2 years) 52,000 Book value, end of second year $ 88,000
(continued)
Revising Depreciation Estimates
10
During 2012, the company estimates that the remaining useful life is eight years (instead of three) and that the residual value is $8,000 (instead of $10,000). Depreciation expense for each of the remaining eight years is determined as follows:
Book value, end of second year$88,000
Less revised estimated residual value 8,000
Revised remaining depreciation cost$80,000
Revised annual depreciation expense[($88,000 – $8,000) ÷ 8 years] $10,000
Revising Depreciation Estimates
10
Book Value of Asset with Change in Estimate
10
63
3Journalize entries for the disposal of
fixed assets.
Learning Objective Number
10 Discarding Fixed Assets
A piece of equipment acquired at a cost of $25,000 is fully depreciation at December 31, 2009. On February 14, 2010, the equipment is discarded.
10
Equipment costing $6,000, with no residual value, is depreciated at an annual straight-line rate of 10%. After the December 31, 2009, adjusting entry, Accumulated Depreciation—Equipment has a $4,750 balance. On March 24, 2010, the asset is removed from service and discarded.
$600 × 3/12
Discarding Fixed Assets
10
The discarding of the equipment is then recorded as follows (note that this is the second of two entries on March 24):
Discarding Fixed Assets
10 Selling Fixed Assets
Equipment was purchased at a cost of $10,000. It had no estimated residual value and was depreciated at a straight-line rate of 10%. The equipment is sold for cash on October 12 of the eighth year of its use. The balance of the accumulated depreciation account as of the preceding December 31 is $7,000.
10
The entry to update the depreciation for the nine months of the current year is as follows:
Selling Fixed Assets
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The equipment is sold on October 12 for $2,250. No gain or loss.
Assumption 1
Selling Fixed Assets
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Assumption 2The equipment is sold on October 12 for
$1,000; a loss of $1,250.
Selling Fixed Assets
10
Assumption 3The equipment is sold on October 12 for
$2,800; a gain of $550.
Selling Fixed Assets
10
c. Cash ................................................................................ 168,500 Accumulated Depreciation—Equipment ...................... 87,750 Loss on Disposal of Fixed Assets ................................ 9,250 Equipment ................................................................. 265,500
d. Cash ................................................................................ 180,000 Accumulated Depreciation—Equipment ...................... 87,750 Equipment ................................................................. 265,500 Gain on Sale of Equipment ...................................... 2,250
Straight-line method:( $265,500 - $31,500 ) ÷ 8 = $29,250 2007
( $265,500 - $31,500 ) ÷ 8 = $29,250 2008
( $265,500 - $31,500 ) ÷ 8 = $29,250 2009
$265,500 $87,750 $177,750
Exercise 10-18
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4Compute
depletion and journalize the
entry for depletion.
Learning Objective Number
10
The process of transferring the cost of natural resources to an expense account is called depletion.
Natural Resources
10
A business paid $400,000 for the mining rights to a mineral deposit estimated at 1,000,000 tons of ore.
Step 1: Determine the depletion rate per ton.
Cost of ResourcesEstimated Total Units
of Resources
Depletion Rate =
Natural Resources
10
$400,0001,000,000
$.40 per ton =
A business paid $400,000 for the mining rights to a mineral deposit estimated at 1,000,000 tons of ore.
Step 1: Determine the depletion rate per ton.
Natural Resources
10
A business paid $400,000 for the mining rights to a mineral deposit estimated at 1,000,000 tons of ore.
Step 2: Multiply the depletion rate by the quantity extracted during period.
$0.40 per ton × $90,000 tons = $36,000
Natural Resources
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The adjusting entry to record the depletion is shown below.
Natural Resources
10
Cost Est Total Units16,200,000 / 90,000,000 = 0.18 Depletion Rate
13,750,000 Quantity Mined2,475,000 Deleption Expense
Exercise 10-19
Depletion Expense ................................................ 2,475,000 Accumulated Depletion ............................................ 2,475,000 Depletion of mineral deposit.
10
80
5Describe the
accounting for intangible assets, such as patents, copyrights, and
goodwill.
Learning Objective Number
10
Patents, copyrights, trademarks, and goodwill are long-lived assets that are useful in the operations of a business and not held for sale. These assets are called intangible assets because they do not exist physically.
Intangible Assets
10
The exclusive right granted by the federal government to manufacturers to produce and sell goods with one or more unique features is a patent. These rights continue in effect for 20 years.
Scotch Tape and Dollar Store
Patent
10
At the beginning of its fiscal year, a business acquires a patent right for $100,000. Its remaining useful life is estimated at 5 years.
Amortizing a Patent
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Because a patent (and other intangible assets) does not exist physically, it is acceptable to credit the asset. This approach is different from physical fixed assets that require the use of a contra asset account.
Amortizing a Patent
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The exclusive right granted by the federal government to publish and sell a literary, artistic, or musical composition is a copyright. A copyright extends for 70 years beyond the author’s death.
Copyright
10
A trademark is a unique name, term, or symbol used to identify a business and its products. Most businesses identify their trademarks with ® in their advertisements and on their products. Trademarks can be registered for 10 years and can be renewed every 10-year period thereafter.
Trademark
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In business, goodwill refers to an intangible asset of a business that is created from such favorable factors as location, product quality, reputation, and managerial skill.
Goodwill
10
Generally accepted accounting principles permit goodwill to be recorded in the accounts only if it is objectively determined by a transaction.
Goodwill
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A loss should be recorded if the business prospects of the acquired firm (and the acquired goodwill) become significantly impaired.
Impaired Goodwill
10
Disclosures for 600 FirmsExhibit 9
Frequency of Intangible Asset
10 Comparison of Intangible Assets
Exhibit 10
10
Cost Useful Life750,000 / 15 = 50,000 Amortization
90,000 / 12 = 7,500 Amortization57,500 Total Amortization
Exercise 10-20
Amortization Expense—Patents............................... 57,500 Patents ....................................................................... 57,500 Amortized patent rights ($50,000 + $7,500).
10
93
6Describe how depreciation expense is
reported in an income statement
and prepare a balance sheet
Learning Objective Number
10
10
• The cost and related accumulated depletion of mineral rights are normally shown as part of the Fixed Assets section of the balance sheet.
• Intangible assets are usually reported in the balance sheet, supported by a note with a separate listing.
• The balance in each class of intangible assets should be disclosed net of any amortization.
Balance Sheet
10 Fixed Asset Turnover Ratio
One measure of the revenue-generating efficiency of fixed assets is the fixed asset turnover ratio. It measures the number of dollars of revenue earned per dollar of fixed assets and is computed as follows:
Fixed Asset Turnover Ratio
Revenue
Average Book Value of Fixed
Assets
=
10 For Marriott International, Inc.
(in millions)
Fixed Asset Turnover Ratio
Revenue
Average Book Value of Fixed Assets
=
Fixed Asset Turnover Ratio
$12,160
($1,238 + 2,341)/2 =
Fixed Asset Turnover Ratio = 6.79
10
98
A1Sum-of-the-Years-
Digits Depreciation
Learning Objective Number
10
An asset costs $24,000, has a five-year life, and an estimated salvage value of $2,000. Annual depreciation using sum-of-the-years-digits method is shown in the column shaded in yellow.
Sum-of-the-Years-Digits Method
10
Sum of Years of Useful Life = 2
1) + N(N =
2
1) + 20(20 = 210
First year: 20/210 × $75,000 = $7,143
Second year: 19/210 × $75,000 = $6,786
Exercise 10-23
10
101
A2Exchanging
Similar Fixed Assets
Learning Objective Number
10 Exchanging Similar Fixed Assets
10 Exchanging Similar Fixed Assets
Per footnote, different according to the IRS:Generally, if you exchange business or investment property solely for business or investment property of a like-kind, no gain or loss is recognized under Internal Revenue Code Section 1031. If, as part of the exchange, you also receive other (not like-kind) property or money, gain is recognized to the extent of the other property and money received, but a loss is not recognized.
Section 1031 does not apply to exchanges of inventory, stocks, bonds, notes, other securities or evidence of indebtedness, or certain other assets.
10
Calculating the Gain
Price (fair market value) of new equipment $5,000Less assets given up in exchange:
Book value of old equipment ($4,000 – $3,200) $ 800Cash paid on the exchange 3,900 4,700
Gain on exchange of assets $ 300
Exchanging Similar Fixed Assets
10
Loss on Exchange of Similar Assets
This time assume that only a $675 trade-in allowance was allowed towards the purchase of the new equipment. Because the market value of the new equipment is $5,000, the cash paid on the exchange amounts to $4,325.
Exchanging Similar Fixed Assets
10 Exchanging Similar Fixed Assets
10
a.
Price (fair market value) of new equipment ....................................... $300,000 Trade-in allowance of old equipment ................................................. 120,000 Cash paid on the date of exchange .................................................... $180,000
b.
Price (fair market value) of new equipment ..................... $300,000 Less assets given up in exchange: Book value of old equipment ..................................... $115,500 Cash paid on the exchange ....................................... 180,000 295,500 Gain on exchange of equipment ...................................... $ 4,500
Exercise 10-26
10
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THE ENDTHE END
CHAPTER 10